In a previous article, I invited readers to entertain the notion that using life insurance products to create or enhance retirement income is fraught with difficulties related to “illustration noncompliance” and carrier-related policy management shortcomings.
Based on the responses I received, it seems clear that life insurance agents understand these issues and are frustrated by the lack of tools available for properly analyzing and managing products that have nonguaranteed and unreliable return assumptions and expense factors. I could not agree more.
A number of agents told me they were disappointed they could not get in-depth, in-force product information from their brokerage general agencies or carriers. Some said their frustration with trying to get policy service representatives to even understand their questions has undermined their confidence in selling these products. Apparently, and this should come as no surprise, the life insurance industry is much more focused on selling products then they are on properly managing them.
Identifying a problem is the first step to solving it. Yet these products always have been marketed without independent analytics that would allow both agent and client to evaluate policies based on their internal pricing and validation of the illustrative assumptions with proper benchmarks, or even an industry-endorsed methodology for doing so.
In my view, all products with nonguaranteed components, including traditional and indexed dividends, that are sold to create a future “defined benefit” require much more rigorous analysis. Yet when discussing this topic with carriers, we are most often met with blank stares. Every carrier executive understands this issue and almost none wants to spend the money to solve it. Even worse is the prevalent attitude that no carrier wants to be the first to do anything for fear of losing their perceived competitive position! This is why positive change is so difficult to achieve.
Any carrier actuary will tell you they use stochastic/probabilistic analysis to make product pricing decisions, price options and pay dividends. They all know the benefits and limitations of the products they design, but they never share this information with the public. While I understand that there are huge legal and competitive obstacles to disclosing the “secret sauce,” I would argue that the buying public’s right to know supersedes any compliance posturing.
After all, when we make an investment in a mutual fund, the fund manager is required to tell us how our money will be invested, how much they will charge us and what guidelines are in place to assure us that the investment strategy will be adhered to. This data is easily accessed and can be sliced, diced and compared to other strategies using a plethora of third-party software.
When making long-term investment decisions that have a significant impact on our ability to retire, nothing less will do. Add to that a fiduciary standard to “walk in the client’s shoes” when making recommendations and you have a system that at least makes a credible effort to be transparent.
Blessed and Cursed
We in the life insurance industry are equally blessed and cursed in this regard. Blessed because indexed universal life (IUL), a complicated investment product in all aspects, is beyond the purview of the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Cursed, because this allows manufacturers to wall off their products and hide their pricing assumptions, features, and implicit loads and risks.
Imagine the uproar if a newly introduced mutual fund was allowed to hide management fees from prospective investors. How many registered reps would sell that fund without knowing the impact of nonguaranteed fees? How many broker/dealers would allow that? Yet the majority of life insurance agents are selling IUL without the slightest inkling of how the carriers pricing assumptions compare and/or conflict with what is illustrated.
From a marketing perspective, we are now witnessing a whole subculture of IUL abuse by invitation-only seminars that encourage participants to stop investing in qualified plans and annuities and use IUL policies as the cornerstone of their retirement plan. Someone even is advertising in the life industry trade magazines touting the huge commissions agents will earn using his “technique,” while at the same time telling seminar attendees that the product they are buying is the most cost-effective way to retire! Only one of those statements can be true, and I am pretty certain it isn’t the one about cost effectiveness.
This is a slippery slope, and one the industry should address quickly. If historical patterns prevail, mass seminar selling presages the beginning of a process that will conclude in class action lawsuits.
What’s a responsible professional to do? Obviously, we aren’t going to walk away from selling IUL. What we need to do is stop relying on illustrations that are severely misleading and wrong as soon as they are printed.
To represent our clients properly, we must understand exactly how IUL products work, what assumptions were made by the issuer and how close those assumptions are to the issuer’s ability to make them come true. We need industry benchmarks for mortality assumptions, expenses, investment strategy, options pricing and every other aspect of indexed policies that might affect our clients’ outcomes. We need to make the industry come clean about nonguaranteed and often nondisclosed “black box” bonuses. We’ve seen this before, and the ending is always the same — our clients are disappointed and lawyers sue.
We are better than this! But the nature of the insurance industry and its patchwork of state regulators allows and, in some cases, encourages carriers to resist disclosure of their policy assumptions.
Probability of Success
In our practice, we use a composite of carrier-provided software and proprietary stochastic/probabilistic modeling to attempt to get as close as possible to the real probability of success. Although each of these programs provides valuable data, none is 100 percent correct.
However, this creates output that compares products, predicts the probability that each policy will deliver the desired result and shows the differences in internal cost structures. It’s a start, but definitely not what we regard as the finished product. That would require industry participation and product disclosures that are currently being withheld.
To understand and properly recommend a product that will be used to provide a future income stream, you need to know the answers to the following questions:
1. What gross rate of return does the selected index need to achieve in order to validate the AG 49 or another illustrated rate?
2. Is the carrier’s maximum AG 49 rate too aggressive? Unlike investments in true market indexes, life insurance policies limit the client’s ability to affect the outcome, and therefore the AG 49 rate needs to be scrutinized to account for this limitation.
3. How are cap rates determined? Is there a direct correlation to external interest rates? Can changes in cap rates be benchmarked? What is the carrier’s history with cap rates?
4. How are participation rates determined? How much latitude does the carrier have in determining the rates? Can they be benchmarked?
5. Is the illustrated cost of insurance rate achievable, and what is the carrier’s history with raising cost of insurance rates on older blocks of business?
6. Are there persistency bonuses? Are they guaranteed? If not, what factors could change the calculations?
7. Is the client willing to participate in regular evaluations (at least once every five years) and amend the pattern of premium payments according to the policy performance over time?
With the exception of No. 7, these are hard questions that carriers struggle to answer. However, if producers, banks, wire houses and B/Ds were to convince carriers that this data is required before any product can be recommended, their bad attitude toward full disclosure might dissipate.
We are involved in an industry project to make stochastic forecasting and product benchmarking available as an adjunct to, but not a replacement for, illustrations. This project would also include the ability for clients to access their policy data, obtain policy-specific probability analysis and make changes as necessary to their policies for as long as they own them. All of this is sorely needed and at the current time not on the list of carrier things to do.
We could really use some help with this project. The only way to make it happen is for those involved with distribution, from carrier marketing executives to agents, to say they can’t continue selling black box products without responsible evaluation and management tools. Call your BGA, independent marketing organization or carrier(s) and tell them that IUL product disclosures are inadequate and that participating in promoting independent, third-party tools to evaluate products responsibly is of vital importance.
With these tools, we can elevate our game, help our clients succeed and maybe even save the reputation of an industry desperately in need of some positive publicity.